Why Key Person Insurance is Crucial for Business Owners
Most businesses have certain individuals who are integral to its success - these key people could be the founder (you!), a top salesperson, or a highly-skilled employees whose absence would severely disrupt operations.
When a key person dies or is unable to work due to sickness or a major health event, your business faces significant risks, both financially and operationally. Mitigating these risks is crucial for the long-term stability and resilience of the business.
Financial Consequences to the Business
Revenue Loss: The sudden unavailability of a key person (including yourself!) can lead to a significant drop in revenue. For example, if a top salesperson or someone responsible for major client relationships is no longer available, the business might struggle to maintain sales and client confidence.
Operational Disruptions: Key people often have unique skills and knowledge that are difficult to replace. Their absence can cause quality issues, delays, and significant day-to-day disruptions.
Increased Costs: The process of finding, hiring and then training a replacement can be time-consuming and very costly. Interim solutions like hiring temp staff or consultants can also add to the financial burden.
Personal Consequences for Business Owners
Stress and Uncertainty: The sudden loss of a key person can create huge personal stress for business owners. Uncertainty and disruptions can be very overwhelming, and your workload may also increase if you have to take on additional responsibilities yourself.
Financial Strain: The loss of a crucial person can cause financial strain that impact a business owner’s personal finances (especially if they have personally guaranteed business loans or invested a significant portion of their savings into the business).
Mitigating Financial Risks with Key Person Insurance
Key person insurance is a valuable tool that can help a business manage the financial risks associated with the loss of a key individual.
Key Person insurance provides a payout to the business in the event of the insured person's death or inability to work due to a covered illness or injury.
Here are some ways the funds from key person insurance can be used:
Repaying Debt: The insurance payout can be used to repay business debts, preventing the burden from falling on the remaining partners or the personal assets of the business owners.
Covering Operational Costs: The funds can provide the business with sufficient liquidity to cover operational costs, such as salaries and rent, during the period of transition and adjustment.
Hiring a Replacement: Finding and training a replacement for a key person can be expensive. The insurance payout can help cover recruitment, training, and onboarding costs, ensuring that the business can find a suitable replacement without financial strain.
Stabilising the Business: In some cases, the insurance proceeds can be used to stabilise the business and maintain customer and investor confidence until the key person is able to return to work or a permanent replacement is found.
Tax Benefits and Tax Deductibility
An important aspect of key person insurance is its potential tax benefits, which can make it a more attractive and cost-effective option for businesses.
When a business holds the insurance policy, there are several tax implications to consider that can reduce the financial burden:
Tax-Deductible Premiums: The premiums paid for key person insurance may be tax-deductible as a business expense. This can significantly reduce the overall cost of the insurance, making it more affordable for the business. Contact us for more information on the tax deductibility of insurance for your business.
Tax-Free Benefits: Typically, the proceeds from a key person insurance policy are received by the business tax-free. This means that the full amount of the insurance payout can be used to cover the financial needs of the business without being reduced by taxes.
Reduction in Personal Financial Responsibility: By having the business hold the key person insurance policy, the financial responsibility does not fall on the individual business owners. This protects the business, while also preserving the personal finances of the owners, as they don’t have to pay the premiums out of their own pockets.
Business Continuity Planning: The potential tax benefits associated with key person insurance can support broader business continuity planning. By incorporating these insurance policies into the overall financial strategy, businesses can ensure they are well-prepared for unexpected events without incurring significant out-of-pocket expenses.
Shareholder Agreements
If you have a Company, your shareholder agreement should include provisions for key person insurance. This is a prudent step that protects both the business and its stakeholders from the uncertainties of life, ensuring that the business can navigate challenges with resilience and confidence.
The sudden loss of a key person can have massive financial and operational consequences for a business.
However, key person insurance provides a safety net that helps businesses weather the storm and continue to thrive.
Contact us today, and let’s get you and your business some protection.
Our blog is not intended to be taken as personal advice and is for informational purposes only.
Before acting on this information, contact us to ensure it is suitable for your circumstances.